ESG funds hitting their stride with record-level inflows

Advisers and investors take notice as more funds achieve three-year track records showing solid performance.

Sustainable investing strategies have suddenly become the magic bullet for mutual funds and exchange-traded funds.

The latest data from Morningstar Inc. show funds that focus on environmental, social and governance issues attracted $8.9 billion worth of net inflows during the first six months of the year.

That compares to $5.5 billion for all of 2018 and represents a trend that isn’t likely to slow anytime soon, according to Jon Hale, global head of sustainability research at Morningstar Research Services.

“The interest in sustainable investing continues to grow and there are more funds and products available,” he said. “We’re also getting to the point where the wave of new [funds] that started in 2014 have been hitting their three-year marks.”

Mr. Hale points to an increased focus on the environment in 2014 as a tipping point in the ESG space, as the interest among investors started to outpace the supply of products and resulted in a flood of new mutual funds and ETFs that employed ESG strategies.

Mr. Hale said there are now at least 40 funds that have reached the three-year mark, which is a crucial measurement for most financial advisers and institutional investors.

“Starting around September 2014, asset managers started ramping up new products,” he said. “The growth in the number of funds was partly driven by demand from investors and partly driven by it being an area where there weren’t a lot of funds yet in an asset management industry that is always looking for new product opportunities.”

The broad category of ESG funds had record net flows of $4.7 billion in the quarter ending June 30, following the previous record of $4.1 billion in the first quarter of this year, which was more than double the $1.9 billion of net flows during the fourth quarter of 2018.

Almost 60% of the net inflows into ESG funds this year went into lower-cost ETFs, but Mr. Hale said the actively managed mutual funds are holding their own.

Asset flows in each of the past two quarters were boosted by Ilmarinen, Finland’s largest pension fund, which invested more than $800 million in iShares ESG MSCI USA Leaders ETF (SUSL) at its second-quarter launch and invested a similar amount in Xtrackers MSCI USA ESG Leaders Equity ETF (USSG) at its first-quarter launch.

While the Ilmarinen investments had an impact, Mr. Hale said 2019 has also seen large institutional investors pull their original seed capital from several funds, suggesting Ilmarinen was not the only reason for the strong inflow numbers.

SUSL was the second-quarter leader with $1.37 billion in net flows, followed by TIAA-CREF Social Choice Bond Fund (TSBHX) with $520 million, Vanguard FTSE Social Index Fund (VFTSX) at $368 million and USSG at $277 million.

In addition to more ESG funds earning three-year track records, Morningstar data show that funds’ performance is keeping pace.

A broad industry report by Morningstar on sustainable investing earlier this year shows that 35% of ESG funds ranked in the top performance quartile of their respective Morningstar fund categories in 2018, and only 18% finished in the bottom quartile.

One thing that is not yet driving flows into ESG funds is company-sponsored retirement savings plans, where ESG funds are still a rare menu option.

“Retirement plans have been slow to adopt ESG options and when they do, these are stand-alone options rather than target-date series,” Mr. Hale said. “The vast majority of assets go into target-date series as they are default options.”